The Bank of England’s quarterly inflation report has revealed downgraded growth forecasts for the UK economy and a calmer projection of UK inflation. Higher prices may not be positive for me and you as consumers, but investors love high inflation, because the best tool for controlling it is raising interest rates (and we all love higher interest rates...as long as we are not borrowing).
The market was prepared for a more pessimistic outlook for UK economy. Growth figures over the past quarter have taken a turn for the worse and expectations are not for a strong rebound, so the Bank of England’s forecasts stand to reason.
On the upside for sterling, Mervyn King gave us no reason to think they are moving any closer to introducing further quantitative easing. Nonetheless, the Bank of England will be satisfied to ride out the expected spike up to 5% in UK inflation in the short-term, before watching prices ease fairly rapidly next year. In the absence of high inflation in 2012 and with growth likely to be stodgy, a Bank of England rate hike looks unlikely to come at all next year at this stage. The Bank of England is mirroring the Fed’s monetary policy outlook to a certain extent; no QE yet and certainly no rate hike for a long time.
What we are seeing is uncertainty in the global economy filtering into central bank monetary policy. Near-term interest rate bets in Australia, New Zealand, Norway and the eurozone have all been scaled back as a result of the eurozone debt panic and fears of another US recession; people really don’t know what’s going to happen.
Sterling recovered from a knee-jerk sell-off against both the euro and the dollar; after all, there were no great surprises from the report or from King. This afternoon has seen equities suffer another sell-of, which has seen risk currencies, including the euro suffer some fairly sharp declines. The US Federal Reserve’s statement last night has clearly done little to ease market fears that the US economy is heading back into a recession, not to mention the unresolved debt crisis in the eurozone. Speculation is also surfacing that France (a core eurozone nation) may lose its AAA credit rating, just as the US has recently done at the hands of Standard and Poor’s.
Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.
